Scenario: Using the same situation from the Module 3
SLP, recall that you are deciding among three investments. You have
heard of an expert who has a highly reliable “track record” in the
correct identification of favorable vs. unfavorable market conditions.
You are now considering whether to consult this “expert.” Therefore, you
need to determine whether it would be worth paying the expert’s fee to
get his prediction. You recognize that you need to do further analysis
to determine the value of the information that the expert might provide.In order to simplify the analysis, you have decided to look at two
possible outcomes for each alternative (instead of three). You are
interested in whether the market will be Favorable or Unfavorable, so
you have collapsed the Medium and Low outcomes. Here are the three
alternatives with their respective payoffs and probabilities.Option A: Real estate development. This is a risky
opportunity with the possibility of a high payoff, but also with no
payoff at all. You have reviewed all of the possible data for the
outcomes in the next 10 years and these are your estimates of the Net
Present Value (NPV) of the payoffs and probabilities:High/Favorable NPV: $7.5 million, Pr = 0.5Unfavorable NPV: $2.0 million, Pr = 0.5Option B: Retail franchise for Just Hats, a
boutique-type store selling fashion hats for men and women. This also is
a risky opportunity but less so than Option A. It has the potential for
less risk of failure, but also a lower payoff. You have reviewed all of
the possible data for the outcomes in the next 10 years and these are
your estimates of the NPV of the payoffs and probabilities.High/Favorable NPV: $4.5 million, Pr = 0.75Unfavorable NPV: $2.5 million, Pr = 0.25Option C: High Yield Municipal Bonds. This option
has low risk and is assumed to be a Certainty. So there is only one
outcome with probability of 1.0:NPV: $2.25 million, Pr = 1.0You have contacted the expert and received a letter stating his track
record which you have checked out using several resources. Here is his
stated track record:True State of the MarketExpert PredictionFavorableUnfavorablePredicts “Favorable”.9.3Predicts “Unfavorable”.1.7You
realize that this situation is a bit complicated since it requires the
expert to analyze and predict the state of two different markets: the
real estate market and the retail hat market. You think through the
issues of probabilities and how to calculate the joint probabilities of
both markets going up, both going down, or one up and the other down.
Based on your original estimates of success, here are your calculations
of the single probabilities and joint probabilities of the markets.ProbabilitiesFavorableUnfavorableA: Real Estate0.500.50B: Just Hats0.750.25Joint ProbabilitiesA Fav, B Fav (A+, B+)0.375A Unf, B Unf (A-, B-)0.125A Fav, B Unf (A+, B-)0.125A Unf, B Fav (A-, B+)0.375Finally,
after a great deal of analysis and calculation, you have determined the
Posterior probabilities of Favorable and Unfavorable Markets for the
Real Estate business and the boutique hat business.Real EstateJust HatsFUFU0.45says “F/F”0.750.250.900.100.15says “F/U”0.750.250.300.700.30says “U/F”0.1250.8750.900.100.10says “U/U”0.1250.8750.300.70For
example, this table says that there is 45% chance that the expert will
predict Favorable for both markets (F/F), and when he makes this
prediction, there is a 75% chance that the Real Estate market will be
favorable and 25% chance that it won’t, and also a 90% chance that the
Hat market will be Favorable and 10% chance it won’t.You have developed a Decision Tree showing the original collapsed
solution and also showing an expanded Decision Tree for evaluating the
value of the expert’s information. You need to enter the probabilities
into this tree to see if the expert’s information will increase the
overall expected value of your decision. Download the Excel file with
the incomplete Decision Tree: Decision Tree for BUS520 SLP 4AssignmentComplete the information in the Decision Tree in the Excel file.
Determine the Expected NPV of the decision if you were to consult the
Expert. Does use of the Expert increase the value of your analysis? If
so, by how much?Write a report to your private investment company and explain your
analysis and your recommendation. Provide clear rationale/ justification
for your decision.AnalysisAccurate and complete analysis in Excel.Required:Length requirements: 2–3 pages minimum (not including Cover and Reference pages). NOTE: You must submit 2–3 pages of written discussion and analysis. This means that you should avoid use of tables and charts as “space fillers.”Provide a brief introduction to/background of the problem.Written analysis that supports Excel analysis and provides thorough discussion of assumptions, rationale, and logic used.
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